European equities have outshone their US counterparts since an autumn nadir as investors bet that cooling energy prices and a reopening China will soften the region’s economic slowdown this year.
The benchmark Stoxx Europe 600 index has risen 18 per cent since bottoming out in late September, outstripping a 9.4 per cent gain for Wall Street’s blue-chip S&P 500 over the same period.
European equities have spent much of the period since the 2008 financial crisis lagging behind those in the US, where racier technology stocks in particular benefited from record-low interest rates and central bank largesse. The inflation-driven reversal of those policies last year sparked a stock market sell-off on either side of the Atlantic from which European equities have since bounced back faster than those on Wall Street.
London’s FTSE 100, which is stacked with energy companies, banks and consistent dividend payers that outperformed during last year’s market tumult, is at its highest point since August 2018. Meanwhile, Germany’s Dax and France’s Cac 40 have risen 7 per cent since the start of January, taking their gains over the past three months above 20 per cent.
European stocks’ bumpy ride higher during the final quarter of 2022 came as prices of natural gas declined from their late-August peak, dragging down eurozone inflation in the process and easing pressure on the European Central Bank to keep raising interest rates in jumbo 0.75 percentage point increments.
The easing of strict zero-Covid policies in China — Europe’s biggest trading partner — provided a further boon, lifting luxury goods groups which depend on Chinese demand for much of their revenues.
“I am not a European bull, I had a recession scenario for 2023, but I’m now raising my outlook to a mild slowdown,” said Agnès Belaisch, chief European strategist at the Barings Investment Institute. “So much bad news was priced in, the derating was extreme. A slowdown rather than a recession means a completely different ballgame.”
Europe was the largest customer in the global liquefied natural gas market in 2022, with the extra supply and warmer weather having so far helped to avert an energy crisis this winter which many had expected to cripple economies and exacerbate a cost of living crisis for consumers already grappling with sky-high inflation.
Analysts at Goldman Sachs no longer expect a “technical recession” in Europe this year, with the region’s economy now forecast to grow 0.6 per cent in 2023 rather than shrink by 0.1 per cent.
Analysts at Citi now expect “the mildest earnings recession [in Europe] since 1970” and for the Stoxx 600, which the US bank recently upgraded to overweight, to rise by around 9 per cent through to the end of the year. The S&P 500 is forecast to rise by less than half as much over the same period.
European stocks are also relatively cheap. Last year’s dramatic market sell-off ensured equities listed on the MSCI Europe now trade at a 12-month forward price to earnings multiple of around 12 times — below their long-term average and at the biggest discount to US equities in 30 years, according to Citi’s analysis.
History suggests that bodes well for shares as Europe’s economy slows and corporate earnings forecasts begin to be scaled back.
“Prices in general go down in anticipation of earnings recessions, but the entry valuation is what influences whether the market subsequently rises or falls,” said Citi equity analyst Beata Manthey, who notes that the MSCI Europe gained ground during three of the past four earnings recessions it entered at a discount to its own long-term average.
The lingering threat of recession and the ECB’s main interest rate at 2 per cent, up from minus 0.5 per cent in July, mean that Citi favours value stocks, inexpensive companies with consistent earnings, over pricier, fast-growing companies. Banks, insurance and healthcare groups are among Citi’s favourite picks.
Some analysts and investors doubt how long Europe’s outperformance has left to run, however. Ankit Gheedia, head of European equities and derivatives strategy at BNP Paribas, expects the region’s stock markets to plumb new lows in 2023 as recession bites.
“European equities remain under-loved and under-owned,” Gheedia said in a note. “We expect companies to lose pricing power in a stagflationary environment,” he added, with inflation staying higher for longer and increased wages weighing on companies’ bottom lines.
Analysts at JPMorgan point out that the ECB will probably remain focused on fighting inflation, even as economic growth slows. ECB president Christine Lagarde said in December that markets were underestimating how much higher borrowing costs could yet go, warning that investors should anticipate rates rising “at a 50-basis-point pace for a period of time”.
“We recommend taking profits on European stocks,” the US bank said.